When did you buy your house? Chances are, if it was more than a few years ago and you haven't refinanced, current interest rates are lower than what you got when you initially took out your loan.
And lower interest rates mean less money spent on your mortgage.
Wondering how to take advantage of these low rates? Read on to learn about three strategies for refinancing - and how they could help you pay less on your mortgage.
Strategy #1 - Lower Your Interest Rate by at Least .5 to 1 Percent
If you want to cut down your monthly payments, refinancing your mortgage to the same terms as you have now - but at a lower interest rate - is one solution.
According to a "December 2012 U.S. Economic & Housing Market Outlook" published by Freddie Mac, "mortgage rates fell to 65-year lows after the Federal Reserve began its third round of quantitative easing in September [of 2012]." This basically refers to the U.S. buying mortgage-backed securities in an effort to artificially stimulate the economy. And Freddie Mac expects rates to remain near record lows for the first half of 2013, though they might start going up at the end of this year.
"[Refinancing to a lower rate] can save someone a lot of money," Manke says. "Though it depends on the amount of reduction in the interest rate you'd need to make it ideal. One percent or [higher] is great, but sometimes it can even make sense to refinance for as little as half a percent reduction - as long as the costs of the loan are minimal and you're going to stay in the house for long enough to recoup the costs of the loan."
The Numbers: Let's say you've got a 30-year fixed $200K mortgage with a 4.5 percent interest rate. How would your situation change if you could refinance to a new loan at 3.5 percent? Let's plug in the numbers.
|4.5 percent interest rate||3.5 percent interest rate|
|Total Interest Paid:||$164,813.42||$123,312.18|
By refinancing to a loan with an interest rate lowered by only 1 percent, you'll see monthly savings of $115.28 - and an overall savings of $41,501.24 in interest over the life of the loan.
But keep in mind that there are costs associated with the loan and you'll have to pay fees to refinance to a new mortgage. However, the cost of refinancing could be well worth it considering the potential savings down the road.
Strategy #2 - Switch to a 15-Year Mortgage Term
If you can afford a larger monthly payment, refinancing from a 30-year to a 15-year loan could help you own your home sooner and save you big in interest.
"This is absolutely something you could do," Manke says. "The only thing to consider is if you need to free up capital - for example, [if] you need to put [money] in your retirement savings or pay for your kid's college - you might not want to commit to the higher monthly payment."
However, you'll also want to keep in mind that the interest rate on a 15-year mortgage vs. a 30-year mortgage is generally lower. So, depending on your current and new interest rates, that monthly payment might not even be much higher with a 15-year loan. Take a look at the example below to see what we mean.
The Numbers: Let's assume - once again - that you've got a 30-year mortgage of $200K at 4.5 percent interest. What would happen if you refinanced to a 15-year mortgage with an interest rate of 2.76 percent, the average from March 28, 2013, according to Freddie Mac?
|30-year loan||15-year loan|
|Interest Rate:||4.5 percent||2.76 percent|
|Total Interest Paid:||$164,813.42||$44,475.13|
You'll be paying $344.83 more every month since the term is shorter, but you'll be saving a whopping $120,338.29 over the life of the loan.
So, as you can see, if you can afford the higher monthly payment, the savings could be huge. "It's your money, don't give it to the bank," Manke says. "If you can afford the 15-year mortgage - go for it."
Strategy #3 - Do a Cash-Out Refinance to Pay off Higher-Rate Credit Card Debt
Are you buried in credit card debt and paying massive interest on your balance? Here's a solution that might not be ideal for everyone, but something to consider: Doing a cash-out refinance to take cash out of your home's equity and using that money to wipe out your credit card debt.
Here's why it could work for some people: Since the interest rate on your home is most likely much lower than the interest rate on your credit card, you'll be paying less money overall in interest if you do a cash-out refinance and use the cash to pay off your credit card debt.
"I think that this can definitely serve a purpose," says Manke. The one caveat, he adds, is that you need to have equity in your home to get this loan.
The Numbers: Let's say you've got a balance of $30K on a credit card and you're paying 20 percent interest on it. You've also got the $200K mortgage at a 4.5 percent interest rate. Assuming that you make the minimum $600 payment on your credit card each month - and don't make any additional charges, here's how your total payments might pan out:
|Interest Rate:||4.5 percent||20 percent|
|Repayment Time:||30 years||94 years|
|Total Interest Paid:||$164,813.42||$146,168|
To break it down, your monthly payment for both credit card and mortgage is $1,613.37, and you'll pay a total of $310,981.42 in interest over the life of both loans. (That is, if you live long enough to pay off that credit card debt!)
Now, let's say you decide to do a cash-out refinance to a new 30-year fixed loan of $230K (the $200K mortgage you currently have, plus the $30K to pay off your credit card debt) at the same rate of 4.5 percent. Here's what the numbers will look like side-by-side:
|Before Cash-Out Refi||After Cash-Out Refi|
|Loan Amount:||$200,000 + $30,000 credit card debt||$230,000|
|Repayment Time:||94 years||30 years|
|Total Interest Paid:||$310,981.42||$189,535.44|
So by paying off your credit card debt with a cash-out refinance, you'll save $447.91 every month, and see a total savings of $121,445.98 in interest over the life of the loan. Not to mention those 64 years you'll shave off of paying your credit card debt.
However, Manke does recommend people think very carefully before jumping into this situation."I'd caution people not to run up debts again... they might only have the chance [to do this cash-out refinance] once."
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